August 25, 2016

In July 2016, the German government decided
to abolish the country’s feed-in tariff (FIT) for renewable
electricity generation. Instead, the government now plans to auction contracts
for renewable electricity deployment to the lowest bidders.

The FIT is a policy that basically forces electric utilities
to buy renewable electricity from generators for a premium price. Since 1990,
the German FIT had played a key role in making the country a pioneer in the use
of renewable energy. Why did Germany replace the FIT after almost three decades
of unparalleled growth in renewable electricity generation?

As a policy, the FIT has many virtues in the early stages of
renewable electricity generation. It reduces uncertainty for electricity
producers as the FIT guarantees a fixed, above-market price for a defined time
period, such as ten years.

The German
law also gives priority to renewable electricity, thus granting grid
access to renewable producers. This design protects independent small-scale
producers by preventing electric utilities from closing the electricity market. Politically,
this feature is key to understanding the FIT’s popularity: it creates benefits
to a large number of small generators.

No wonder, then, that the FIT has been the most critical
driver behind Germany’s aggressive growth in renewables. In fact,
renewable electricity generation since 1990 increased by a factor of ten, with
renewables now accounting for almost a third in the country’s electricity mix.

However, the cost of the FIT policy increases over time, as
the cost of generating renewable electricity declines. This development
typically shows in increased electricity prices for household customers. As a
result of the FIT, average retail prices have soared, at least over the last
decade. Residential consumers are charged about 35 cents/kWh compared to about
13 cents/kWh in the United States, making Germany the country of some of the
highest electricity prices in Europe.

Germany’s decision to drop the FIT policy and to become an
auctioneer is thus an attempt to control the rate and cost of growth in
renewable electricity generation. Auctioning not only promises to reduce the
cost of renewable electricity generation, but it also gives policymakers more
flexibility in achieving their goals.

The German government can now create “deployment
corridors” by setting renewable energy production targets for different
technologies. In turn, the “breathing caps” adjust the premium for renewables
depending on how well actually installed capacities match targets.

The move into auctions also shows political acumen. Now that
renewable electricity generation is much cheaper than just a decade ago, rapid
growth in the sector is no longer the overriding priority. Now the question is
whether Germany can keep increasing the share of renewables in the power sector
without continued increases in electricity prices and other problems, such as
outages.

Indeed, the German FIT had recently drawn a lot of fire. Critics
of the FIT point to the continued use of polluting coal in Germany, as
renewables have reduced the use of natural gas and nuclear power. Others note
that electricity has now become a “luxury good” in Germany, no longer
affordable to the poor.

Now that cost-effectiveness of renewable production is
becoming more and more important relative to mere growth, tailoring cash
incentives towards the government’s strategic expansion plans is key to
success. Auctions enable continued growth in renewables at a low cost relative
to the FIT, while giving the government more control over technologies and
types of renewables. In this sense, auctions promise to be a useful tool in
Germany’s pursuit of a “new normal” in renewable electricity production.

In applauding the Merkel government’s policy choice, we do
not want to belittle the challenges of designing auctions. It remains to be
seen if – and how much – the German auctions reduce the cost of renewable
capacity installation and whether the disappearance of the certainty provided
by the FIT creates problems.

A particular challenge for Germany is that auctions are not
suited for supporting the growth of small-scale, distributed renewable electricity
generation. Because small producers cannot compete on cost basis with major
players or do the complicated paperwork in bidding, different policies are
needed to support this segment. The goal here must be to continue to support
distributed electricity generation in the country of Bürgerenergie –
citizen energy. The German government recognizes
these issues.

For example, small installations still benefit from an FIT up
to a certain limit.

To sum it all up, the German government is again leading the
way in renewable energy policy. Auctions are the future for renewable energy
now that the sector has left growing pains behind. However, much depends on the
design of auctions and finding the right complementary policies for
small-scale, distributed renewable electricity generation.